The OBBB Dependent Care FSA Increase Could Backfire

Question: Will employees be able to take advantage of the OBBB dependent care FSA increase to $7,500 in 2026? 

Short Answer: Given the a) nature of the 55% average benefits test, b) OBBB enhancements to the child and dependent care tax credit, and c) disproportionate use of the dependent care FSA by highly compensated employees, it is possible the new OBBB landscape could inadvertently lead to reduced access to the dependent care FSA in 2026. 

Upon walking out of the Constitutional Convention in the summer of 1787, Benjamin Franklin was reportedly asked what type of government the Framers had devised for the fledgling nation.  His response: “A republic, if you can keep it.”  

If a member of Congress had been asked about the “One Big Beautfiul Bill Act” (OBBB) benefit enhancements for working families when walking out of the Capitol in the summer of 2025, an appropriate response would have been: “A dependent care FSA increase, if you can use it.”  

The OBBB Increases the Dependent Care FSA Limit to $7,500 in 2026 
Congress set the dependent care FSA (DCFSA) limit at $5,000 in 1986 without indexing it to inflation.  With the exception of a one-year blip, the DCFSA has remained at that level for 40 years.  Among the many benefits-related changes in the bill, the OBBB sets a new $7,500 DCFSA limit ($3,750 for married couples filing separately) starting in 2026.    

• For more details: How the One Big Beautiful Bill Affects Employee Benefits 

The OBBB Also Enhances the Child and Dependent Care Tax Credit in 2026 
The child and dependent care tax credit (CDCTC) provides a credit on the individual tax return for the same types of employment-related daycare expenses that are reimbursable through a DCFSA.  The CDCTC allows taxpayers to claim the credit for a percentage of $3,000 (one dependent) or $6,000 (two or more dependents) spent on qualifying expenses.    

In 2025, the applicable CDCTC percentage of that $3,000/$6,000 amount is a sliding scale that starts at 35% and phases down until reaching a floor of 20% for incomes over $43,000.  The OBBB changes the applicable percentage as of 2026 to start at 50%, phasing down in a more favorable (and complex) two-tier approach first to 35% based on income intervals in excess of $15k, then again to 20% with a different formula for income in excess of $75k (single) or $150k (married, filing jointly).  The First Five Years Fund estimates that nearly four million families will see an increased CDCTC—including dual-income households earning up to $206k and single-income households earning up to $103k—and that married couples with two or more children and income levels below $150k will able to claim an additional $900 from the enhanced CDCTC.  

How the DCFSA and CDCTC Interact 
Employees utilizing the DCFSA generally have minimal access to the CDCTC to avoid prohibited “double-dipping”.  Any amounts reimbursed through the DCFSA correspondingly reduce the $3,000/$6,000 starting point amount used to calculate the CDCTC.  For example, an employee with two children who reimburses $5,000 through the DCFSA would have only $1,000 remaining to apply to the CDCTC.  That leaves a CDCTC of just $200 (20% of $1,000) available to claim at many income levels.  

More Employees May Shift to the CDCTC 2026 
Prior to the OBBB changes taking effect, most employees have been better served by utilizing the DCFSA than claiming the CDCTC.  Starting in 2026, it is possible that calculus for many employees will flip to instead favor the CDCTC.    

There are a lot of variables in making this determination for each individual (e.g., marital status, number of dependents, income level, FICA taxes, state income taxes, effect on other tax credits).  The complexity of this determination should become a major discussion point for personal tax advisers.  As an initial very rough shorthand for 2026, it appears that lower and middle income families (generally below $150k) may receive a better tax advantage through the enhanced CDCTC than the increased DCFSA.    

• Bottom-line: Employees are likely to avoid the DCFSA irrevocable election requirements, use-it-or-lose-it rule, and administrative hassle of submitting claims for reimbursement if they believe they can receive at least a comparable tax treatment though claiming the CDCTC instead. 

The DCFSA 55% Average Benefits Test: The Thorn in Employers’ Side 
DCFSAs are a component of the Section 125 cafeteria plan.  Cafeteria plans are subject to a variety of nondiscrimination rules.  The 55% average benefits test (ABT) that applies to the DCFSA is by far the most difficult to pass.  DCFSAs that are nondiscriminatory in their plan design are nonetheless frequently unable to pass the ABT based on the plan’s utilization rates.  

The test looks to the average benefit received by highly compensated employees (HCEs) as a ratio compared to the average benefit received by non-highly compensated employees (NHCEs), requiring that the NHCE average be at least 55% of the HCE average.  HCEs generally are defined as more-than-5% owners of the employer in the preceding or current year, or employees who earned more than $160k (2026 testing threshold) in the prior year.  

HCEs tend to disproportionately participate at higher levels and make higher dependent care FSA elections, which is exactly what the ABT is designed to prevent.  That makes the ABT very hard to pass without adjustments to reduce HCE elections—even at the pre-OBBB DCFSA election limit.  

For more details: 

• Newfront Office Hours Webinar: Section 125 Cafeteria Plans 

• The Dependent Care FSA 55% Average Benefits Test 

Will Employees Be Able to Take Advantage of the OBBB DCFSA Increase? 
The snowball effect as more NHCEs consider declining the DCFSA in favor of claiming the enhanced CDCTC will take time to develop as personal tax advisers begin to assess the relative benefits and potentially counsel clients toward the CDCTC.  Eventually, the result is likely to drain a meaningful amount of NHCE participation away from the DCFSA.  If this trend develops as anticipated, it will exacerbate the challenge employers already face in passing the ABT.   

The shiny headline of the increased $7,500 DCFSA limit may therefore prove an unattractive addition for NHCEs.  It may also prove to be an elusive target for HCEs unable to reach the new tax-advantaged heights because of ABT limitations.  There is even the unfortunate possibility that the NCHE shift out of the DCFSA (in favor of the CDCTC) will cause HCEs to ultimately have access to a lower DCFSA benefit (after application of the required ABT reductions) than was available before the OBBB increase.  

Can Anything Be Done to Pass the ABT at the New OBBB DCFSA Levels? 
Employers could consider some form employer contribution to entice greater NHCE participation in the DCFSA, similar to the strategies used to pass 401(k) plan to pass nondiscrimination testing.  For example, employers could offer NHCE DCFSA participants a dollar-for-dollar match of up to $500 per year to incentivize greater NHCE participation/elections and improve the chances of passing the ABT.  Traditionally this has not been a common DCFSA approach because of the additional cost, but employers that are motivated to pass the ABT might consider it. 

Summary  
“A dependent care FSA increase, if you can use it.” 

The relevant committees of the House and the Senate primarily responsible for the OBBB both have made efforts to emphasize the bill’s new benefits for working families, including the enhanced CDCTC and increased DCFSA.  However, the cumulative effect of both changes, paired with the enduring restrictions imposed by the applicable nondiscrimination rules, has the potential to actually result in reduced access to the DCFSA.   

Employers are left to grapple with that potential as they prepare for 2026 open enrollment, and the looming first round of post-OBBB nondiscrimination testing that will soon follow.  In the meantime, employers should begin working with their FSA TPA to prepare any cafeteria plan amendments, update employee summary materials, and distribute open enrollment materials that educate employees on these OBBB changes. 

Relevant Cites: 

The One Big Beautiful Bill Act: 
SEC. 70404. ENHANCEMENT OF THE DEPENDENT CARE ASSISTANCE PROGRAM.  
(a) IN GENERAL.—Section 129(a)(2)(A) is amended by striking ‘‘$5,000 ($2,500’’ and inserting ‘‘$7,500 ($3,750’’.  
(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable years beginning after December 31, 2025.  

SEC. 70405. ENHANCEMENT OF CHILD AND DEPENDENT CARE TAX CREDIT.  
(a) IN GENERAL.—Paragraph (2) of section 21(a) is amended to read as follows:  
‘‘(2) APPLICABLE PERCENTAGE DEFINED.—For purposes of paragraph (1), the term ‘applicable percentage’ means 50 percent—  
‘‘(A) reduced (but not below 35 percent) by 1 percentage point for each $2,000 or fraction thereof by which the taxpayer’s adjusted gross income for the taxable year exceeds $15,000, and  
‘‘(B) further reduced (but not below 20 percent) by 1 percentage point for each $2,000 ($4,000 in the case of a joint return) or fraction thereof by which the taxpayer’s adjusted gross income for the taxable year exceeds $75,000 ($150,000 in the case of a joint return).’’.  
(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable years beginning after December 31, 2025. 

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship.  Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).